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Global growth: Speeding up towards a slowdown

After the rollercoaster ride of 2016, the previous year was probably the first one in which the “new normal” didn’t feel so bad. That may in part be due to the power of low expectations – just think of all the bad things that did not came to pass in 2017! But there were also a number of positive developments that should be acknowledged.

Global growth in 2017 will likely have reached its highest level since 2010 and surprised on the upside for the first time in six years. Perhaps more importantly, the global economic recovery is finally becoming more inclusive. Global growth is now fairly synchronized: some measures of discrepancies of growth across countries are at their lowest levels in decades. Average unemployment rates are coming down across virtually all advanced economies. Laggards like Italy or Brazil are finally beginning to recover, businesses are beginning to invest and even the Greek economy appears to have bottomed out, even though it continues to lag the global momentum.

The good news is that these current trends are likely to continue, and probably even strengthen in 2018. Overall, we expect that the global economy will have another moderately strong year and that it may surprise positively once more. In the eurozone, unemployment will probably drop to levels last seen in 2008. References to the “euroboom” increasingly outnumber those to the “eurozone crisis.”

The bad news is that the outlook continues to be blemished by a number of major risks and that the world appears ill-prepared for the eventual turning point.

Four types of risks stand out. First, asset markets are showing increasing signs of exuberance. For instance, in the US, the value of the stock market relative to GDP is now at an all-time high. Meanwhile, the rating agencies report that most private debt securities are currently issued with weak investor protections. Much optimism already appears to be reflected in asset prices. Meanwhile, monetary policy rates are slowly going up and, with the US Federal Reserve reducing its balance sheet and the ECB halving its asset purchase, the long period of central bank stimulus seems to be nearing its end. Risks of a painful correction in asset markets are therefore rising.

Second, given very low unemployment in some countries, including Japan, Germany or the US, inflation may finally rear its head. If rising wages drive the pickup in inflation that would certainly be welcome. But any sign that a pickup in inflation may not be as gradual and well-controlled as central banks would like it to be, would likely cause significant volatility in world financial markets and dampen global animal spirits.

Third, political and geopolitical risks remain rife. No solution is in sight in North Korea, tensions in the Middle East, including between some of the world’s largest oil producers, continue to rise and the US appears determined to change the global trade order. On trade, the world’s two largest economies, the US and China, are increasingly at odds.

Fourth, the Chinese economy could slow down more sharply than currently expected. The modest pickup in Chinese growth in 2017, which was propelled by significant state stimulus, was a major factor behind the global momentum. Recently, the Chinese economy is sending mixed signals again. More broad-based global growth can absorb the modest slowdown our China team expects in 2018. But acute weakness in the Chinese economy would be a major challenge for global growth, too.

Jointly, these risks suggest that we are slowly but surely nearing the end of this rather lengthy, if very uneven, global expansion. Indeed, the stronger the current positive momentum plays out, the sooner the world may hit its next turning point – the day may appear brightest just before sunset. Cautious spending by households, governments and businesses partly explain why this recovery has been so slow to date, but it also prevented the over-spending and over-investment that invariably leads to retrenchment.

If and when we hit the next global slowdown, high public debt levels and low interest rates mean the expediency and creativity of policymakers will undoubtedly be in high demand. The US business cycle is more advanced than elsewhere and the response of US policymakers will be critical. Yet for now, US politicians appear bent on cutting taxes rather than building buffers. This is despite the fact that the IMF expect the US general government deficit in 2017 to be around 4.5 percent of GDP, roughly three times the deficit in the eurozone and more than twice the deficit in Greece (figures that become even more alarming given that the US now enjoys unemployment at multi-decade lows and low interest rates).

Caustic observers sometimes say that Europe never misses an opportunity to miss an opportunity. Excessive austerity certainly prolonged the eurozone’s Great Recession. One can only hope that the planned fiscal stimulus in the US will not end up in a similar category of regrets.